UNITED STATES
SECURITY AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20849
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2007
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT
FOR THE TRANSITION PERIOD
COMMISSION FILE NUMBER 0-50237
VSB Bancorp, Inc.
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(Name of Small Business Issuer in its charter)
New York
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(State or other jurisdiction of incorporation or organization)
11 - 3680128
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(I. R. S. Employer Identification No.)
4142 Hylan Boulevard, Staten Island, New York 10308
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(Address of principal executive offices)
(718) 979-1100
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Issuer's telephone number
Common Stock
------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
Transitional small business disclosure format: Yes [ ] No [X]
The Registrant had 1,891,759 common shares outstanding as of October 29, 2007.
CROSS REFERENCE INDEX
Page
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PART I
Item 1 Consolidated Statements of Financial Condition as of September 30, 2007 and
December 31, 2006 (unaudited) 4
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2007 and 2006 (unaudited) 5
Consolidated Statements of Changes in Stockholders' Equity for the Nine Months Ended
September 30, 2007 and the Year Ended December 31, 2006 (unaudited) 6
Consolidated Statements of Cash Flows for the Three and Nine Months Ended
September 30, 2007 and 2006 (unaudited) 7
Notes to Consolidated Financial Statements for the Three and Nine Months Ended
September 30, 2007 and 2006 (unaudited) 8 to 14
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 14 to 24
Item 3 Control and Procedures 24
PART II
Item 1 Legal Proceedings 25
Signature Page 26
Exhibit 31.1, 31.2, 32.1, 32.2 27 to 30
2
Forward-Looking Statements
When used in this periodic report, or in any written or oral statement
made by us or our officers, directors or employees, the words and phrases "will
result," "expect," "will continue," "anticipate," "estimate," "project," or
similar terms are intended to identify "forward-looking statements." A variety
of factors could cause our actual results and experiences to differ materially
from the anticipated results or other expectations expressed in any
forward-looking statements. Some of the risks and uncertainties that may affect
our operations, performance, development and results, the interest rate
sensitivity of our assets and liabilities, and the adequacy of our loan loss
allowance, include, but are not limited to:
o deterioration in local, regional, national or global economic
conditions which could result in, among other things, an increase in
loan delinquencies, a decrease in property values, or a change in
the real estate turnover rate;
o changes in market interest rates or changes in the speed at which
market interest rates change;
o changes in laws and regulations affecting the financial service
industry;
o changes in competition; and
o changes in consumer preferences by our customers or the customers of
our business borrowers.
Please do not place undue reliance on any forward-looking statement, which
speaks only as of the date made. There are many factors, including those
described above, that could affect our future business activities or financial
performance and could cause our actual future results or circumstances to differ
materially from those we anticipate or project. We do not undertake any
obligation to update any forward-looking statement after it is made.
3
VSB Bancorp, Inc.
Consolidated Statements of Financial Condition
(unaudited)
September 30, December 31,
2007 2006
------------- -------------
Assets:
Cash and due from banks $ 32,251,699 $ 25,363,069
Investment securities, available for sale 109,947,323 113,770,611
Loans receivable 59,473,650 66,410,677
Allowance for loan loss (965,641) (1,128,824)
------------- -------------
Loans receivable, net 58,508,009 65,281,853
Bank premises and equipment, net 4,020,292 1,554,363
Accrued interest receivable 805,338 805,681
Deferred taxes 1,431,393 2,030,647
Other assets 1,032,845 3,078,535
------------- -------------
Total assets $ 207,996,899 $ 211,884,759
============= =============
Liabilities and stockholders' equity:
Liabilities:
Deposits:
Demand and checking $ 62,409,088 $ 67,371,582
NOW 19,960,831 19,935,769
Money market 23,585,125 18,359,007
Savings 11,109,695 12,526,485
Time 63,607,910 68,229,244
------------- -------------
Total Deposits 180,672,649 186,422,087
Escrow deposits 399,145 261,063
Subordinated debt 5,155,000 5,155,000
Accounts payable and accrued expenses 1,860,339 2,306,312
------------- -------------
Total liabilities 188,087,133 194,144,462
------------- -------------
Employee Stock Ownership Plan Repurchase Obligation -- 399,026
Stockholders' equity:
Common stock, ($.0001 par value, 3,000,000 shares
authorized, 1,891,759 issued and outstanding at
September 30, 2007 and December 31, 2006) 189 189
Additional paid in capital 9,042,545 8,667,665
Retained earnings 12,827,271 11,293,200
Unearned Employee Stock Ownership Plan shares (1,113,097) (1,239,905)
Accumulated other comprehensive loss,
net of taxes of $738,969 and $1,203,679,
respectively (847,142) (1,379,878)
------------- -------------
Total stockholders' equity 19,909,766 17,341,271
------------- -------------
Total liabilities and stockholders'
equity $ 207,996,899 $ 211,884,759
============= =============
See notes to consolidated financial statements.
4
VSB Bancorp, Inc.
Consolidated Statements of Operations
(unaudited)
Three months Three months Nine months Nine months
ended ended ended ended
Sep. 30, 2007 Sep. 30, 2006 Sep. 30, 2007 Sep. 30, 2006
------------- ------------- ------------- -------------
Interest and dividend income:
Loans receivable $ 1,500,123 $ 1,794,879 $ 4,573,820 $ 5,301,788
Investment securities 1,320,528 1,336,087 3,914,686 3,862,518
Other interest earning assets 297,268 282,049 809,094 594,676
------------- ------------- ------------- -------------
Total interest income 3,117,919 3,413,015 9,297,600 9,758,982
Interest expense:
NOW 37,940 27,867 96,689 77,512
Money market 137,741 85,246 321,150 264,909
Savings 24,531 23,607 74,314 62,985
Subordinated debt 89,040 89,040 267,119 267,119
Time 619,975 662,769 1,862,985 1,647,723
Other interest expense -- 1,112 -- 1,112
------------- ------------- ------------- -------------
Total interest expense 909,227 889,641 2,622,257 2,321,360
Net interest income 2,208,692 2,523,374 6,675,343 7,437,622
Credit for loan loss (15,000) (25,000) (45,000) --
------------- ------------- ------------- -------------
Net interest income
after provision for loan loss 2,223,692 2,548,374 6,720,343 7,437,622
------------- ------------- ------------- -------------
Non-interest income:
Loan fees 15,658 16,973 63,658 57,273
Service charges on deposits 457,023 366,716 1,319,422 1,143,444
Net rental income/(loss) (2,568) 1,083 (876) 7,832
Other income 69,524 62,151 233,989 200,395
------------- ------------- ------------- -------------
Total non-interest income 539,637 446,923 1,616,193 1,408,944
------------- ------------- ------------- -------------
Non-interest expenses:
Salaries and benefits 936,903 909,308 2,892,221 2,911,028
Occupancy expenses 352,297 275,324 1,032,022 814,374
Legal expense 52,384 117,258 50,750 279,579
Professional fees 56,700 46,000 153,000 136,000
Computer expense 64,604 69,611 201,975 192,236
Directors' fees 52,600 53,950 160,450 167,400
Other expenses 318,873 317,875 974,050 934,915
------------- ------------- ------------- -------------
Total non-interest expenses 1,834,361 1,789,326 5,464,468 5,435,532
------------- ------------- ------------- -------------
Income before income taxes 928,968 1,205,971 2,872,068 3,411,034
Provision for income taxes:
Current 381,296 515,262 1,229,835 1,544,749
Deferred 51,393 46,580 108,162 44,475
------------- ------------- ------------- -------------
Total provision for income taxes 432,689 561,842 1,337,997 1,589,224
------------- ------------- ------------- -------------
Net income $ 496,279 $ 644,129 $ 1,534,071 $ 1,821,810
============= ============= ============= =============
Basic income per common share $ 0.27 $ 0.35 $ 0.84 $ 1.00
============= ============= ============= =============
Diluted net income per share $ 0.26 $ 0.34 $ 0.82 $ 0.98
============= ============= ============= =============
Comprehensive income $ 1,261,399 $ 1,606,183 $ 2,066,807 $ 1,804,679
============= ============= ============= =============
Book value per common share $ 10.52 $ 8.88 $ 10.52 $ 8.88
============= ============= ============= =============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006.
See notes to consolidated financial statements.
5
VSB Bancorp, Inc.
Consolidated Statements of Changes in Stockholders' Equity
Year Ended December 31, 2006 and Nine Months Ended September 30, 2007
(unaudited)
Accumulated
Number of Additional Unearned Other Total
Common Common Paid-In Retained ESOP Comprehensive Stockholders'
Shares Stock Capital Earnings Shares Loss Equity
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at December 31,
2005 1,509,822 $ 151 $ 8,743,200 $ 8,621,693 $ (1,408,983) $ (1,424,127) $ 14,531,934
Reclass due to the
adoption of SEC SAB 108 -- -- -- 125,914 -- -- 125,914
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at January 1,
2006 1,509,822 151 8,743,200 8,747,607 (1,408,983) (1,424,127) 14,657,848
Exercise of stock option,
including tax benefit 3,750 46,232 46,232
Amortization of earned
portion of ESOP common
stock 169,078 169,078
5 for 4 stock split and
purchase of fractional
shares 378,187 38 (367) (329)
Amortization of deficit
fair value of cost -
ESOP (6,785) (6,785)
Transfer to ESOP
repurchase obligation (114,615) (114,615)
Comprehensive income:
Net income 2,545,593 2,545,593
Other comprehensive
income, net:
Change in unrealized
loss on securities
available for sale,
net of tax effects -- -- -- -- -- 44,249 44,249
------------- ------------- ------------- ------------- ------------- ------------- -------------
Total comprehensive income 2,589,842
Balance at December 31,
2006 1,891,759 189 8,667,665 11,293,200 (1,239,905) (1,379,878) 17,341,271
------------- ------------- ------------- ------------- ------------- ------------- -------------
Amortization of earned
portion of ESOP common
stock 126,808 126,808
Amortization of deficit
fair value of cost -
ESOP (24,146) (24,146)
Transfer from ESOP
repurchase obligation 399,026 399,026
Comprehensive income:
Net income 1,534,071 1,534,071
Other comprehensive
income, net:
Change in unrealized
loss on securities
available for sale,
net of tax effects -- -- -- -- -- 532,736 532,736
------------- ------------- ------------- ------------- ------------- ------------- -------------
Total comprehensive income 2,066,807
Balance at September 30,
2007 1,891,759 $ 189 $ 9,042,545 $ 12,827,271 $ (1,113,097) $ (847,142) $ 19,909,766
============= ============= ============= ============= ============= ============= =============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006.
See notes to consolidated financial statements.
6
VSB Bancorp, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Three months Three months Nine months Nine months
ended ended ended ended
Sep. 30, 2007 Sep. 30, 2006 Sep. 30, 2007 Sep. 30, 2006
------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 496,279 $ 644,129 $ 1,534,071 $ 1,821,810
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 160,243 112,586 468,265 330,144
Accretion of income, net of amortization
of premium (58,635) (66,629) (166,619) (254,021)
ESOP compensation expense 31,123 41,344 102,662 125,364
Credit for loan losses (15,000) (25,000) (45,000) --
Decrease/(increase) in prepaid and other
assets 78,465 (722,076) (97,176) (1,049,623)
(Increase)/decrease in accrued interest
receivable (10,013) 9,338 343 (92,502)
Decrease/(increase) in deferred income
taxes 51,393 46,580 134,543 44,475
Increase/(decrease) in accrued expenses
and other liabilities 209,488 338,455 (445,973) (19,299)
------------- ------------- ------------- -------------
Net cash provided by operating
activities 943,343 378,727 1,485,116 906,348
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in loan receivable 1,419,437 5,808,450 6,961,389 8,081,181
Proceeds from repayment of investment
securities, available for sale 11,598,851 5,909,777 24,358,579 16,031,264
Purchases of investment securities,
available for sale (8,002,116) -- (19,513,770) (23,944,173)
Purchases of premises and equipment (36,193) (41,271) (791,328) (530,615)
------------- ------------- ------------- -------------
Net cash provided by/(used in) investing
activities 4,979,979 11,676,956 11,014,870 (362,343)
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease)/increase in deposits (8,654,645) (3,834,277) (5,611,356) 4,140,330
Exercise stock option -- 4,062 -- 46,232
5 for 4 stock split and the purchase of
fractional shares -- -- -- (329)
------------- ------------- ------------- -------------
Net cash provided by financing
activities (8,654,645) (3,830,215) (5,611,356) 4,186,233
------------- ------------- ------------- -------------
NET (DECREASE)/INCREASE IN CASH AND CASH
EQUIVALENTS (2,731,323) 8,225,468 6,888,630 4,730,238
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 34,983,022 27,828,917 25,363,069 31,324,147
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 32,251,699 $ 36,054,385 $ 32,251,699 $ 36,054,385
============= ============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest $ 793,429 $ 731,263 $ 2,844,837 $ 2,172,489
============= ============= ============= =============
Taxes $ 300,000 $ 450,000 $ 1,507,459 $ 1,676,059
============= ============= ============= =============
Transfer of construction in progress to
premises and equipment $ -- $ -- $ 2,142,866 $ --
============= ============= ============= =============
See notes to consolidated financial statements.
7
VSB BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 2007 AND 2006
--------------------------------------------------------------------------------
1. GENERAL
VSB Bancorp, Inc. ("Bancorp" or "Company") became the holding company for
Victory State Bank ("Bank"), a New York State chartered commercial bank on May
30, 2003 as the result of a reorganization of the Bank into the holding company
form of organization. The stockholders of the Bank became the stockholders of
VSB Bancorp, Inc. as a result of the reorganization, receiving three shares of
VSB Bancorp, Inc. stock for each two shares of Victory State Bank stock. Each
stockholder owned the same percentage interest in VSB Bancorp immediately after
the reorganization that the stockholder owned in the Bank immediately before the
reorganization, subject to immaterial differences due to adjustments for cash in
lieu of fractional shares. VSB Bancorp now owns 100% of the capital stock of the
Bank. No stockholders of the Bank exercised dissenter's rights to receive cash
instead of shares of the Company. The transaction between these entities under
common control was accounted for at historical cost on an "as if pooled basis".
Through the Bank, the Company is primarily engaged in the business of
commercial banking, and to a lesser extent retail banking. The Bank gathers
deposits from individuals and businesses primarily in Staten Island, New York
and makes loans throughout that community. The Bank invests funds that are not
used for lending primarily in government securities, mortgage backed securities
and collateralized mortgage obligations. Customer deposits are insured, up to
the applicable limit, by the Federal Deposit Insurance Corporation ("FDIC"). The
Bank is supervised by the New York State Banking Department and the FDIC.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the significant accounting and reporting
policies followed in preparing and presenting the accompanying consolidated
financial statements. These policies conform with accounting principles
generally accepted in the United States of America ("GAAP").
Principles of Consolidation - The consolidated financial statements of the
Company include the accounts of the Company, including its subsidiary Victory
State Bank. All significant inter-company accounts and transactions between the
Company and Bank have been eliminated in consolidation.
Use of Estimates - The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and the amounts
of revenues and expenses during the reporting period. Actual results can differ
from those estimates. The allowance for loan losses, prepayment estimates on the
mortgage-backed securities and Collateralized Mortgage Obligation portfolios,
contingencies and fair values of financial instruments are particularly subject
to change.
Reclassifications - Some items in the prior year financial statements were
reclassified to conform to the current presentation.
Cash and Cash Equivalents - Cash and cash equivalents consists of cash on
hand, due from banks and interest-bearing deposits. Net cash flows are reported
for customer loan and deposit transactions and interest-bearing deposits.
Regulation D of the Board of Governors of the Federal Reserve system requires
that Victory State Bank maintain non-interest-bearing deposits or cash on hand
as reserves against its demand deposits. The amount of reserves which Victory
State Bank is required to maintain depends upon its level of transaction
accounts. During the fourteen day period from September 27, 2007 through October
10, 2007, Victory State
8
Bank was required to maintain reserves, after deducting vault cash, of
$2,800,000. Reserves are required to be maintained on a fourteen day basis, so,
from time to time, Victory State Bank may use available cash reserves on a day
to day basis, so long as the fourteen day average reserves satisfy Regulation D
requirements. Victory State Bank is required to report transaction account
levels to the Federal Reserve on a weekly basis.
Interest-bearing bank balances - Interest-bearing bank balances mature
overnight and are carried at cost.
Investment Securities, Available for Sale - Investment securities,
available for sale, are to be held for an unspecified period of time and include
securities that management intends to use as part of its asset/liability
strategy. These securities may be sold in response to changes in interest rates,
prepayments or other factors and are carried at estimated fair value. Gains or
losses on the sale of such securities are determined by the specific
identification method. Interest income includes amortization of purchase premium
and accretion of purchase discount. Premiums and discounts are recognized in
interest income using a method that approximates the level yield method without
anticipating prepayments, except for mortgage-backed securities where
prepayments are estimated. Unrealized holding gains or losses, net of deferred
income taxes, are excluded from earnings and reported as other comprehensive
income in a separate component of stockholders' equity until realized. Declines
in the fair value of securities below their cost that are other than temporary
are reflected as realized losses. In estimating other-than-temporary losses,
management considers: (1) the length of time and extent that fair value has been
less than cost, (2) the financial condition and near term prospects of the
issuer, and (3) the Company's ability and intent to hold the security for a
period sufficient to allow for any anticipated recovery in fair value.
The Company invests primarily in agency Collateralized Mortgage-Backed
Obligations ("CMOs") with estimated average lives primarily under 4.5 years and
Mortgage-Backed Securities. These securities are primarily issued by the Federal
National Mortgage Association ("FNMA"), the Government National Mortgage
Association ("GNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC") and
are primarily comprised of mortgage pools guaranteed by FNMA, GNMA or FHLMC. The
Company also invests in whole loan CMOs, all of which are AAA rated. These
securities expose the Company to risks such as interest rate, prepayment and
credit risk and thus pay a higher rate of return than comparable treasury
issues.
Loans Receivable - Loans receivable, that management has the intent and
ability to hold for the foreseeable future or until maturity or payoff, are
stated at unpaid principal balances, adjusted for deferred net origination and
commitment fees and the allowance for loan losses. Interest income on loans is
credited as earned.
It is the policy of the Company to provide a valuation allowance for
probable incurred losses on loans based on the Company's past loan loss
experience, known and inherent risks in the portfolio, adverse situations which
may affect the borrower's ability to repay, estimated value of underlying
collateral and current economic conditions in the Company's lending area. The
allowance is increased by provisions for loan losses charged to earnings and is
reduced by charge-offs, net of recoveries. While management uses available
information to estimate losses on loans, future additions to the allowance may
be necessary based upon the expected growth of the loan portfolio and any
changes in economic conditions beyond management's control. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on judgments
different from those of management. Management believes, based upon all relevant
and available information, that the allowance for loan losses is appropriate.
The Company has a policy that all loans 90 days past due are placed on
non-accrual status. It is the Company's policy to cease the accrual of interest
on loans to borrowers past due less than 90 days where a probable loss is
estimated and to reverse out of income all interest that is due. The Company
applies payments received on non-accrual loans to the outstanding principal
balance due before applying any amount to interest, until the loan is restored
to an accruing status. On a limited basis, the Company may apply a payment to
interest on a non-accrual loan if there is no impairment or no estimated loss on
this asset. The Company continues to accrue interest on construction loans that
are 90 days past contractual maturity date if the loan is expected to be paid in
full in the next 60 days and all interest is paid up to date.
9
Loan origination fees and certain direct loan origination costs are
deferred and the net amount recognized over the contractual loan terms using the
level-yield method, adjusted for periodic prepayments in certain circumstances.
The Company considers a loan to be impaired when, based on current
information, it is probable that the Company will be unable to collect all
principal and interest payments due according to the contractual terms of the
loan agreement. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Impairment is measured on a
loan by loan basis for commercial and construction loans. Impaired loans are
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of the collateral. The fair value of
the collateral, as reduced by costs to sell, is utilized if a loan is collateral
dependent. Large groups of smaller balance homogeneous loans, such as consumer
loans and residential loans, are collectively evaluated for impairment.
Long-Lived Assets - The Company periodically evaluates the recoverability
of long-lived assets, such as premises and equipment, to ensure the carrying
value has not been impaired. In performing the review for recoverability, the
Company would estimate the future cash flows expected to result from the use of
the asset. If the sum of the expected future cash flows is less than the
carrying amount an impairment will be recognized. The Company reports these
assets at the lower of the carrying value or fair value.
Subordinated Debt - In August of 2003, the Company formed VSB Capital
Trust I (the "Trust"). The Trust is a statutory business trust organized under
Delaware law and the Company owns all of its common securities. The Trust issued
$5.0 million of Trust Preferred Capital Securities to an independent investor
and $155,000 of common securities to the Company. The Company issued a $5.16
million subordinated debenture to the Trust. The subordinated debenture is the
sole asset of the Trust. The subordinated debenture and the Trust Preferred
Capital Securities pay interest and dividends, respectively, on a quarterly
basis, at a rate of 6.909%, for the first five years. They mature thirty years
after the issuance of the securities and are non-callable for five years. After
the first five years, the Trust Preferred Securities may be called by the
Company at any quarterly interest payment date at par and the rate of interest
that fluctuates quarterly based upon 300 basis points over the 90 day LIBOR
rate. The Trust is not consolidated with the Company.
Premises and Equipment - Premises, leasehold improvements, and furniture
and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation and amortization are accumulated by the straight-line method over
the estimated useful lives of the respective assets, which range from three to
ten years. Leasehold improvements are amortized at the lesser of their useful
life or the term of the lease.
Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB
system. Members are required to own a certain amount of stock based on the level
of borrowings and other factors, and may invest in additional amounts. FHLB
stock is carried at cost, classified as a restricted security, and periodically
evaluated for impairment. Because this stock is viewed as a long term
investment, impairment is based on ultimate recovery of par value. Both cash and
stock dividends are reported as income.
Income Taxes - The Company utilizes the liability method to account for
income taxes. Under this method, deferred tax assets and liabilities are
determined on differences between financial reporting and the tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
expected to be in effect when the differences are expected to reverse. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
Financial Instruments - In the ordinary course of business, the Company
has entered into off-balance sheet financial instruments, primarily consisting
of commitments to extend credit.
10
Basic and Diluted Net Income Per Common Share - Basic net income per share
of common stock is based on 1,831,436 shares and 1,821,357 shares, the weighted
average number of common shares outstanding for the three months ended September
30, 2007 and 2006, respectively. Diluted net income per share of common stock is
based on 1,876,451 and 1,868,460, the weighted average number of common shares
and potentially dilutive common shares outstanding for the three months ended
September 30, 2007 and 2006, respectively. The weighted average number of
potentially dilutive common shares excluded in calculating diluted net income
per common share due to the anti-dilutive effect is 56,110 and 85,397 shares for
the three months ended September 30, 2007 and 2006, respectively. Common stock
equivalents were calculated using the treasury stock method.
Basic net income per share of common stock is based on 1,828,997 shares
and 1,816,840 shares, the weighted average number of common shares outstanding
for the nine months ended September 30, 2007 and 2006, respectively. Diluted net
income per share of common stock is based on 1,877,025 and 1,865,575, the
weighted average number of common shares and potentially dilutive common shares
outstanding for the nine months ended September 30, 2007 and 2006, respectively.
The weighted average number of potentially dilutive common shares excluded in
calculating diluted net income per common share due to the anti-dilutive effect
is 53,097 and 84,070 shares for the nine months ended September 30, 2007 and
2006, respectively. Common stock equivalents were calculated using the treasury
stock method.
The reconciliation of the numerators and the denominators of the basic and
diluted per share computations for the three and nine months ended September 30,
are as follows:
Three Months Ended Three Months Ended
Reconciliation of EPS September 30, 2007 September 30, 2006
--------------------- --------------------------------------- ---------------------------------------
Weighted Weighted
Net Average Per Share Net Average Per Share
Income Shares Amount Income Shares Amount
----------- ----------- ----------- ----------- ----------- -----------
Basic income per common share
-----------------------------
Net income available to
common stockholders $ 496,279 1,831,436 $ 0.27 $ 644,129 1,821,357 $ 0.35
=========== ===========
Effect of dilutive shares
-------------------------
Weighted average shares, if
converted 45,015 47,103
----------- -----------
Diluted net income per common
share
-----------------------------
Net income available to common
stockholders $ 496,279 1,876,451 $ 0.26 $ 644,129 1,868,460 $ 0.34
=========== =========== =========== =========== =========== ===========
11
Nine Months Ended Nine Months Ended
Reconciliation of EPS September 30, 2007 September 30, 2006
--------------------- --------------------------------------- ---------------------------------------
Weighted Weighted
Net Average Per Share Net Average Per Share
Income Shares Amount Income Shares Amount
----------- ----------- ----------- ----------- ----------- -----------
Basic income per common share
-----------------------------
Net income available to
common stockholders $ 1,534,071 1,828,997 $ 0.84 $ 1,821,810 1,816,840 $ 1.00
=========== ===========
Effect of dilutive shares
-------------------------
Weighted average shares, if
converted 48,028 48,735
----------- -----------
Diluted net income per common
share
-----------------------------
Net income available to common
stockholders $ 1,534,071 1,877,025 $ 0.82 $ 1,821,810 1,865,575 $ 0.98
=========== =========== =========== =========== =========== ===========
Stock Based Compensation - FAS 123, Revised, requires companies to record
compensation expense for stock options provided to employees in return for
employment service. The cost is measured at the fair value of the options when
granted, and this cost is expensed over the employment service period, which is
normally the vesting period of the options. This applies to awards granted or
modified in fiscal years beginning in 2006. Compensation cost will also be
recorded for prior option grants that vest after the date of adoption. The
effect on result of operations will depend on the level of future option grants
and the calculation of the fair value of the options granted at such future
date, as well as the vesting periods provided, and so cannot currently be
predicted.
Stock Options
Options to buy stock are granted to directors, officers and employees
under five stock option plans approved by stockholders between 1998 and 2004
which, in the aggregate, provide for issue up to 243,750 options. Exercise price
is the market price at the date of grant, and compensation expense will be
recognized in the income statement in accordance with FAS 123, Revised. The
maximum option term is ten years, and the options vesting period is up to five
years.
There were no stock option grants in 2007 and 2006.
The stock option components of the five stock option plans, as of
September 30, 2007, and changes during the nine months ended, consist of the
following:
12
2007
---------------------------------
Weighted
Average Aggregate
Exercise Intrinsic
Shares Price Value
--------- --------- ---------
Options outstanding 177,998 $ 10.36
at the beginning of the year
Granted -- --
Canceled -- --
Exercised -- --
---------
Options outstanding at September 30, 2007 177,998 $ 10.36 $ 265,217
========= ========= =========
Options exercisable at September 30, 2007 177,998 $ 10.36 $ 265,217
========= ========= =========
Weighted average remaining contractual life of
options outstanding at September 30, 2007 4.0 Years
Employee Stock Ownership Plan ("ESOP") - The cost of shares issued to the
ESOP, but not yet allocated to participants, is shown as a reduction of
stockholders' equity. Compensation expense is based on the market price of
shares as they are committed to be released to participant accounts. Cash
dividends on allocated ESOP shares reduce retained earnings; cash dividends on
unearned ESOP shares reduce debt and accrued interest. As of March 16, 2007, the
Company lists its common stock on a national exchange, NASDAQ Capital Markets.
We are no longer required to reclassify out of stockholders' equity an amount
equal to the put option of the allocated ESOP shares and we reclassed the 2006
put option allocation in the first quarter of 2007.
Comprehensive Income - Comprehensive income consists of net income and
other comprehensive income. Other comprehensive income includes unrealized gains
and losses, net of taxes, on securities available for sale which are also
recognized as separate components of equity.
Recently-Issued Accounting Standards - SFAS No. 157, "Fair Value
Measurements." SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS 157 is effective for the Company
on January 1, 2008 and is not expected to have a significant impact on the
Company's financial statements.
SFAS No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities-Including an amendment of FASB Statement No. 115." SFAS 159 permits
entities to choose to measure eligible items at fair value at specified election
dates. Unrealized gains and losses on items for which the fair value option has
been elected are reported in earnings at each subsequent reporting date. The
fair value option (i) may be applied instrument by instrument, with certain
exceptions, (ii) is irrevocable (unless a new election date occurs) and (iii) is
applied only to entire instruments and not to portions of instruments. SFAS 159
is effective for the Company on January 1, 2008 and is not expected to have a
significant impact on the Company's financial statements.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
48"), which prescribes a recognition threshold and measurement attribute for a
tax position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. The Company adopted FIN 48 as of
January 1, 2007. A tax position is recognized as a benefit only if it is "more
likely than not" that the tax position would be sustained in a tax examination,
with a tax examination being presumed to occur. The amount recognized is the
largest amount of tax benefit that has a greater than 50% likelihood of being
realized on examination. For tax positions not meeting the "more likely than
not" test, no tax
13
benefit is recorded. The adoption had no affect on the Company's consolidated
financial position or results of operations.
The Company and its subsidiaries are subject to U.S. federal income tax as
well as income tax of the state of New York. The Company is no longer subject to
examination by taxing authorities for years before 2003. The Company does not
expect the total amount of unrecognized tax benefits to significantly increase
in the next twelve months.
The Company recognizes interest related to income tax matters as interest
expense and penalties related to income tax matters as other expense. The
Company did not have any amounts accrued for interest and penalties at January
1, 2007 and September 30, 2007.
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations
Financial Condition at September 30, 2007
Total assets were $207,996,899 at September 30, 2007, a decrease of $3,887,860
or, 1.8%, from December 31, 2006. The decline resulted from deposit outflow,
principally in non-interest demand deposits and time deposit accounts. We funded
the decline in deposits primarily with proceeds from the repayment of investment
securities and loans, which caused a decline in those portfolios during the
quarter. Additional funds generated by the net reduction in loans and the
reduction in the investment securities portfolio were primarily invested in
overnight investments. The net decrease in assets can be summarized as follows:
o A $6,773,844 net decrease in net loans receivable; and
o A $3,823,288 net decrease in investment securities available for sale;
partially offset by
o A $6,888,630 net increase in cash and equivalents.
$2,142,866, reported as construction in progress at December 31, 2006 was
transferred to premises and equipment when we opened and occupied our new main
office at 4142 Hylan Boulevard on February 20, 2007. In addition, we also
experienced changes in other asset categories due to normal fluctuations in
operations.
The decline in loans, our highest yielding asset category, was the result
of a number of factors. The largest component of our loans represent loans to
the residential building trades and related businesses on Staten Island. A slow
down in the housing market has reduced business activity among our customers. In
addition, we have experienced an increase in competition as the number of banks
with offices on Staten Island has increased and some existing local banks have
been acquired by larger banks with greater resources.
Our deposits (including escrow deposits) were $181,071,794 at September
30, 2007, a decrease of $5,611,356, or 3.0%, from December 31, 2006. The
decrease in deposits resulted from decreases of $4,621,334 in time deposits,
$4,824,412 in non-interest demand deposit and $1,416,790 in savings accounts,
partially offset by increases of $5,226,118 in money market accounts and $25,062
in NOW accounts. The decrease in non-interest bearing accounts was due to the
normal fluctuations associated with the demand accounts and a softening of the
real estate market, which lowers our aggregate real estate related demand
deposits.
Total stockholders' equity was $19,909,766 at September 30, 2007, an
increase of $2,568,495 from December 31, 2006. The increase reflected net income
of $1,534,071 for the nine months ended September 30, 2007, a reduction of
$126,808 in Unearned ESOP shares reflecting the effect of the gradual payment of
the loan we
14
made to fund the ESOP's purchase of our stock, and by a decrease in the
unrealized loss on securities available for sale of $532,736. The unrealized
loss is excluded from the calculation of regulatory capital. Management does not
anticipate selling securities in this portfolio, but changes in market interest
rates or in the demand for funds may change management's plans with respect to
the securities portfolio. If there is a material increase in interest rates, the
market value of the available for sale portfolio may decline. Management
believes that the principal and interest payments on this portfolio, combined
with the existing liquidity, will be sufficient to fund loan growth and
potential deposit outflow.
The change in stockholders' equity also included an increase of $374,800
in additional paid in capital primarily due to a $399,026 transfer from the ESOP
repurchase obligation back to additional paid in capital. Our common stock lists
on the NASDAQ Capital Market and therefore we no longer have an obligation to
repurchase stock that the ESOP distributes to participants.
For financial statement reporting purposes, we record the compensation
expense related to the ESOP when shares are committed to be released from the
security interest for the loan. The amount of the compensation expense is based
upon the fair market value of the shares at that time, not the original purchase
price. The initial sale of shares to the ESOP did not increase our capital by
the amount of the purchase price because the purchase price was paid by the loan
we made to the ESOP. Instead, capital increases as the shares are allocated or
committed to be allocated to employee accounts (i.e., as the ESOP loan is
gradually repaid), based upon the fair market value of the shares at that time.
When we calculate earnings per share, only shares allocated or committed to be
allocated to employee accounts are considered to be outstanding. However, all
shares that the ESOP owns are legally outstanding, so they have voting rights
and, if we pay dividends, dividends will be paid on all ESOP shares.
Effect of Adverse Conditions in the Residential Mortgage Market.
We do not expect that adverse conditions in the residential mortgage
market throughout the United States will have a direct adverse effect on our
financial condition or results of operations. We are not a residential mortgage
lender. At September 30, 2007, we owned $104.4 million of securities that are
either collateralized by residential mortgage loans or that represent shares in
pools of such loans. However, 92.6% of those securities are issued or guaranteed
by FNMA, GNMA or FHLMC. The remainder of the securities' portfolio are all
investment grade fixed-rate securities rated AAA that are at least five years
old. None of those securities have experienced ratings downgrades We do not hold
any loans in our portfolio of the type that are commonly known as subprime
residential mortgage loans
Many of our customers, both loan and deposit customers, are involved in
the residential construction business in Staten Island. We believe that the
turmoil in the national housing and residential mortgage markets has had an
adverse effect on some of our customers. An apparent slow down in the local
housing market and a noticeable reduction in the availability of residential
mortgage loans seems to have had an adverse effect on our customers and reduced
their business activity. We believe that this, in turn, has caused a reduction
in their demand for loans from us, such as construction loans to build new
homes. It also appears to have adversely affected the level of deposits they
maintain.
Results of Operations for the Three Months Ended September 30, 2007 and
September 30, 2006
Our results of operations depend primarily on net interest income, which
is the difference between the income we earn on our loan and investment
portfolios and our cost of funds, consisting primarily of interest we pay on
customer deposits. Our operating expenses principally consist of employee
compensation and benefits, occupancy expenses, professional fees, advertising
and marketing expenses and other general and administrative expenses. Our
results of operations are significantly affected by general economic and
competitive conditions, particularly changes in market interest rates,
government policies and actions of regulatory authorities.
15
General. We had net income of $496,279 for the quarter ended September 30,
2007, compared to net income of $644,129 for the comparable quarter in 2006. Two
non-recurring items represented $89,294 of the difference in pre-tax net income.
The September 2006 quarter pre-tax income was benefited by $56,044 of interest
income recognized on a former non-accrual loan that was paid in full during that
quarter. In addition, we reversed $33,250 more in SAR compensation expense in
the 2006 quarter than in the 2007 quarter due to a $3.15 decline in our stock
price during the 2006 quarter.
The principal categories which make up the 2007 net income are:
o Interest income of $3,117,919
o Reduced by interest expense of $909,227
o Increased by non-interest income of $539,637
o Reduced by non-interest expense of $1,834,361
o Reduced by $432,689 in income tax expense
We discuss each of these categories individually and the reasons for the
differences between the quarters ended September 30, 2007 and 2006 in the
following paragraphs. In general, the principal reason for the decline in net
income when comparing the third quarter of 2007 with the same quarter in 2006
was a reduction in interest-earning assets, primarily in the loan portfolio,
which reduced interest income.
Interest Income. Interest income was $3,117,919 for the quarter ended
September 30, 2007, compared to $3,413,015 for the quarter ended September 30,
2006, a decrease of $295,096, or 8.7%. The principal reason for this decrease
was a $9,892,473 decrease in the average balance of our loan portfolio. The
decline in the average balance of loans was the principal component of a
$13,086,211 decline in average interest-earning assets from $207,692,502 for the
third quarter of 2006 to $194,606,291 for the third quarter of 2007. Loans are
our highest yielding asset category, and to the extent that we are unable to
invest available funds in satisfactory loans, we must invest those funds in
lower yielding investment securities and overnight investments at lower yields.
Therefore, the reduction in loans not only reduced the overall volume of
interest-earning assets but also had the effect of reducing the overall average
yield. The $5,100,212 decline in the average balance of investment securities,
partially mitigated by an increase of 16 basis points in the associated yield,
also contributed to the decline in interest income. The $1,906,474 increase in
the average balance of other interest-earning assets was partially offset by the
15 basis point decrease in the average yield on those assets.
The average balance of our loans decreased 14.3% to $59,328,064 for the
quarter ended September 30, 2007 from $69,220,537 during the 2006 quarter. The
decrease in average balance reflects the volatility inherent in the shorter
maturity loans we favor, such as construction loans, the increase in competition
for such loans and the general softening of the real estate market. The
decline in average loan balance was the primary cause of a $294,756 decrease in
interest income from our loan portfolio. In the future, fluctuations in the
prime rate will have a direct effect on our loan yields, except to the extent
that a significant future decline in the prime rate may cause a lesser reduction
in yield because many of our loans have interest rate floors that would be
triggered if such a decline occurs. The average yield on loans decreased by 44
basis points, from 10.19% to 9.75%, but most of this decline was caused by the
effect on the 2006 yield of the payoff of the non-accrual loan discussed above.
The yields on all principal asset categories have begun to decrease as the
Fed Funds rate decreased 50 basis points on September 18, 2007. This caused
decreases in other interest rate indexes, such as the Prime Rate, and market
interest rates generally. The yields on our loan portfolio and our other
interest earning assets, principally short term liquid assets, may decrease more
rapidly than the yield on our investment securities. This occurred because most
of our loans and liquid assets tend to have interest rates that adjust more
quickly as market interest rates change while the rates we earn on our
investment securities are primarily either fixed rates or rates that adjust at
less frequent intervals.
16
The average yield on our investment securities portfolio increased 16
basis points, from 4.56% to 4.72%, due to the purchase of new investment
securities at higher market rates than the yields on the principal paydowns we
received. The yield on investment securities increased slowly because most of
the bonds and notes in our investment portfolio have either fixed interest rates
or interest rates that react more slowly to changes in market interest rate
conditions. The average balance of our investment portfolio decreased by
$5,100,212, or 4.40%, between the periods. The decrease in volume, partially
offset by the increase in yield, resulted in an overall $15,559 decrease in
interest income from investment securities. The investment securities portfolio
represented 82.1% of average non-loan interest earning assets in the 2007 period
compared to 83.9% in the 2006 period.
Finally, we had a $15,219 increase in income from overnight funds and
other interest earning assets due to an increase in average balance. The yield
on these investments decreased 15 basis points from the third quarter of 2006 to
the third quarter of 2007, reflecting a market decline in overnight funds rates
in anticipation of a decline in the target federal funds rate, which the Federal
Reserve reduced by 50 basis points on September 18 2007. The average balance of
overnight investments increased primarily due to the deployment of excess funds
received from the net principal reductions on investments securities and loans.
Interest Expense. Interest expense was $909,227 for the quarter ended
September 30, 2007, compared to $889,641 for the quarter ended September 30,
2006, an increase of 2.2%. The increase was primarily the result of an increase
in the rates we paid on deposits and an increase in the average balance of money
market deposits, partially offset by a reduction in our time deposit portfolio
due to normal maturity runoff.
Our average cost of funds increased from 2.62% to 2.84% between the
periods, primarily due to the increase in the cost of money market deposits and
time deposits and, to a lesser extent, the increased cost of other interest
bearing deposits. Competition and the increase in prevailing market interest
rates required an increase in the rates we offered on both new and renewing time
deposits. Older time deposits originated when market interest rates were lower
were replaced by new deposits created when market interest rates were higher.
Although we had previously moderated the increases we offered on other types of
accounts while market interest rates rose, we were eventually required to adjust
the rates we offered on other deposit types.. Although a decline in the target
federal funds rate towards the end of the third quarter of 2007 reduces the
pressure to raise interest rates, any further increase in competition may
require that we increase the rates we offer to our depositors as more banks
compete for customer deposits.
Net Interest Income Before Provision for Loan Losses. Net interest income
before the provision for loan losses was $2,208,692 for the quarter ended
September 30, 2007, a decrease of $314,682, or 12.5% over the $2,523,374 in the
comparable 2006 quarter. The decrease resulted principally from a decline in the
average balance of our loan portfolio. Our net interest spread decreased to
3.46% in the third quarter of 2007 compared to 3.87% in the third quarter of
2006 and our net interest margin decreased to 4.45% in the third quarter of 2007
compared to 4.79% in the third quarter of 2006, respectively. On the asset side,
the average yield on earning assets in the 2007 period declined to 6.30% from
6.49% in the September 2006 period, or a decrease of 19 basis points. The
principal cause of the decline in average asset yields, and thus the decline in
spread and margin, was the fact that loans represented 30.5% of average earning
assets in the 2007 quarter, down from 33.3% of average earning assets in the
comparable quarter in 2006. The reduction in average loans and the overall
reduction in interest-earning assets had a greater effect than the reduction on
our average yields. On the liability side, there was an increase in our cost of
funds of 22 basis points from 2006, due principally to the increased cost of
money market deposits.
Our margin declined more slowly than our spread because, as most of the
average yields on our assets increase, checking accounts, which represent a
no-cost funding source, become more valuable because we can invest the proceeds
of those deposits at higher yields. However, our average volume of checking
accounts has declined recently. This has resulted from a softening real estate
market, which causes the aggregate balance of demand deposits to decline due to
our strategy of attracting deposits from attorneys and other customers linked to
the real estate businesses. Management continually seeks to maintain a high
level of non-interest checking
17
accounts through developing relationships with local businesses and attorneys.
Maintaining a high percentage of non-interest checking accounts is more
advantageous when market interest rate conditions are high because these no-cost
funds can be invested at the higher yields. However, increases in market
interest rates make interest-bearing deposit products more attractive to
customers and may cause funds to shift from non-interest checking into
interest-bearing deposit products.
Provision for Loan Losses. We took a credit to the provision for loan
losses of $15,000 for the quarter ended September 30, 2007 compared to a credit
to the provision for loan losses of $25,000 for the quarter ended September 30,
2006. The credit was principally the result of the decline in the amount of
loans outstanding. The provision for loan losses in any period depends upon the
amount necessary to bring the allowance for loan losses to the level management
believes is appropriate, after taking into account charge offs and recoveries.
Our allowance for loan losses is based on management's evaluation of the risks
inherent in our loan portfolio and the general economy. Management periodically
evaluates both broad categories of performing loans and problem loans
individually to assess the appropriate level of the allowance.
Although management uses available information to assess the
appropriateness of the allowance on a quarterly basis in consultation with
outside advisors and the board of directors, changes in national or local
economic conditions, the circumstances of individual borrowers, or other
factors, may change, increasing the level of problem loans and requiring an
increase in the level of the allowance. The allowance for loan losses
represented 1.62% of total loans at September 30, 2007, but there can be no
assurance that a higher level, or a higher provision for loan losses, will not
be necessary in the future.
Non-interest Income. Non-interest income was $539,637 for the three months
ended September 30, 2007, compared to $446,923 during the same period last year.
The $92,714, or 20.7%, increase in non-interest income was a direct result of a
$90,307 increase in service charges on deposits (primarily non-sufficient fund
fees), and a $7,373 increase in other income offset by a decrease in net rental
income of $3,651. Service fees on deposit accounts, principally non-sufficient
funds fees, increased from 2006 to 2007 as the volume of deposit account
transactions generating fee income increased. We believe that the increase in
non-sufficient funds may reflect weakness in the local economy. The increase in
other income is a direct result of the Bank taking on a select, limited group of
licensed consumer check cashing companies as deposit customers. These companies
generate fee income through per item charges on their deposits.
Non-interest Expense. Non-interest expense was $1,834,361 for the quarter
ended September 30, 2007, compared to $1,789,326 for the quarter ended September
30, 2006. The principal causes of the $45,035 increase were:
o a $27,595 increase in salaries and benefits expense, due to normal salary
increases, a slight increase in staffing and higher benefit costs;
o a $76,973 increase in occupancy expenses due to the operation of our
branch in Rosebank and the opening of our new main office in Great Kills;
and
o a $64,874 decrease in legal expenses due a reduction in attorney fees from
the 2006 period.
Income Tax Expense. Income tax expense was $432,689 for the quarter ended
September 30, 2007, compared to income tax expense of $561,842 for the quarter
ended September 30, 2006. The reduction in income tax expense was due to the
$277,003 decrease in income before income taxes in the 2007 quarter. Our
effective tax rate remained the same for the quarters ended September 30, 2007
and 2006 at 46.6%.
Results of Operations for the Nine Months Ended September 30, 2007 and September
30, 2006
Our results of operations depend primarily on net interest income, which
is the difference between the income we earn on our loan and investment
portfolios and our cost of funds, consisting primarily of interest we pay on
customer deposits. Our operating expenses principally consist of employee
compensation and benefits, occupancy expenses, professional fees, advertising
and marketing expenses and other general and administrative expenses. Our
18
results of operations are significantly affected by general economic and
competitive conditions, particularly changes in market interest rates,
government policies and actions of regulatory authorities.
General. We had net income of $1,534,071 for the nine months ended
September 30, 2007, compared to net income of $1,821,810 for the comparable nine
months in 2006. The principal categories which make up the 2007 net income are:
o Interest income of $9,297,600
o Reduced by interest expense of $2,622,257
o Increased by a credit to the provision for loan losses of
$45,000
o Increased by non-interest income of $1,616,193
o Reduced by non-interest expense of $5,464,468
o Reduced by $1,337,997 in income tax expense
We discuss each of these categories individually and the reasons for the
differences between the nine months ended September 30, 2007 and 2006 in the
following paragraphs. In general, the principal reasons for the decline in net
income when comparing the first nine months of 2007 with the same period in 2006
were a reduction in average interest-earning assets and higher costs of
deposits, which reduced net interest income, and an increase in occupancy
expenses due to the addition of one new branch office and our new main office,
which was partially offset by a recovery of legal fees that were previously
expensed.
Interest Income. Interest income was $9,297,600 for the nine months ended
September 30, 2007, compared to $9,758,982 for the nine months ended September
30, 2006, a decrease of $461,382, or 4.7%. The principal reason for this
decrease was a $10,154,116 decrease in the average balance of our loan
portfolio. The decline in the average balance of loans was the principal
component of the $8,049,573 decline in average earning assets from $201,898,731
for the nine months of 2006 to $193,849,158 for the first nine months of 2007.
This decline in average loans was partially offset by a seven basis point
increase in the average loan yield. The decrease in interest income from the
decline in average loans was partially mitigated by an increase of $4,640,081 in
the average balance of other interest-earning assets, coupled with the increase
in the associated average yield of 33 basis points on other interest earning
assets. Loans are our highest yielding asset category, and to the extent that we
are unable to invest available funds in satisfactory loans, we must invest those
funds in lower yielding investment securities and overnight investments at lower
yields.
The average balance of our loans decreased 14.3% to $60,982,376 for the
nine months ended September 30, 2007 from $71,136,492 during the 2006 period.
The decrease in average balance reflects the volatility inherent in the shorter
maturity loans we favor, the increase in competition for such loans and the
general softening of the real estate market. The average yield on loans
increased by seven basis points, from 9.91% to 9.98%. The increase in average
yield had a less significant effect than the decline in average loan balance,
which resulted in a $727,968 decrease in interest income from our loan
portfolio. In the future, fluctuations in the prime rate may have a direct
effect on our loan yields, except to the extent that the effect of a significant
future decline in the prime rate may cause a lesser reduction in yield because
many of our loans have interest rate floors that would be triggered if such a
decline occurs.
The average yield on our investment securities portfolio increased 16
basis points, from 4.55% to 4.71%, because we used the proceeds of paydowns on
our existing portfolio to purchase new securities at higher market interest
rates than the yield we had earned on the amount paid down. We accomplished this
without increasing the risk profile of our securities portfolio because market
interest rates had increased and then remained stable. The average balance of
our investment portfolio decreased by $2,535,538, or 2.2%, between the periods.
The increase in yield was partially offset by this decrease in volume, resulting
in an overall $52,168 increase in interest income from investment securities.
The investment securities portfolio represented 83.6% of average non-loan
interest earning assets in the 2007 period compared to 86.9% in the 2006 period.
19
Finally, we had a $214,418 increase in income from overnight funds and
other interest earning assets due to the higher average market rates on short
term and overnight investments and an increase in the corresponding average
balance. The yield on these investments increased 33 basis points from the first
nine months of 2006 to the first nine months of 2007, reflecting the effect of
increases in the federal funds rate during the first half of 2006. The average
balance of overnight investments increased because of the deployment of excess
funds resulting from the net paydowns on investment securities and loans.
Interest Expense. Interest expense was $2,622,257 for the nine months
ended September 30, 2007, compared to $2,321,360 for the nine months ended
September 30, 2006, an increase of 13.0%. More than 90%, or $271,503, of the
$300,897 increase in interest expense was represented by an increase in the cost
of our time deposits and our money market deposits. Although the average balance
of time accounts decreased by $2,956,714, there was a 57 basis point increase in
the average cost of time deposits. Average money market deposits increased by
$1,197,283, and there was a 26 basis point increase in the average cost of those
deposits between the two periods. The increase in rate was due to the increase
in market rates between the two comparable periods, as evidenced by a 100 basis
point increase in the target federal funds rate from January 1, 2006 to July 1,
2006.
Our average cost of funds increased from 2.39% to 2.82% between the
periods, primarily due to the increase in the costs of time and money market
deposits, and to a lesser extent, the increased cost of other interest bearing
deposits. Competition and the increase in prevailing market interest rates
required an increase in the rates we offered on both new and renewing time
deposits.
Net Interest Income Before Provision for Loan Losses. Net interest income
before the provision for loan losses was $6,675,343 for the nine months ended
September 30, 2007, a decrease of $762,279, or 10.3% over the $7,437,622 in the
comparable 2006 period. The decrease resulted principally from the increase in
our cost of funds and the decline in the interest income received from our loan
portfolio due to the reduction in the average balance of our loan portfolio. Our
net interest spread decreased to 3.58% in the first nine months of 2007 compared
to 4.05% in the first nine months of 2006 and our net interest margin decreased
to 4.59% in the first nine months of 2007 compared to 4.91% in the first nine
months of 2006, respectively. On the asset side, the average yield on earning
assets in the 2007 period decreased to 6.40% from 6.44% in the September 2006
period, or a decrease of 4 basis points. On the liability side, there was an
increase in our cost of funds of 43 basis points from 2006. The principal cause
of the decline in average asset yields, and thus the decline in spread and
margin, was the fact that loans represented 31.5% of average earning assets in
the first nine months of 2007, down from 35.2% of average earning assets in the
comparable period in 2006.
Our margin declined more slowly than our spread because, as the average
yields on our assets increase, checking accounts, which represent a no-cost
funding source, become more valuable because we can invest the proceeds of those
deposits at higher yields. However, our average volume of checking accounts has
declined recently. This has resulted from a softening real estate market, which
causes the aggregate balance of demand deposits to decline due to our strategy
of attracting deposits from attorneys and other customers linked to the real
estate businesses. Management continually seeks to maintain a high level of
non-interest checking accounts through developing relationships with local
businesses and attorneys. Maintaining a high percentage of non-interest checking
accounts is more advantageous when market interest rates are high because these
no-cost funds can be invested at the higher yields. However, increases in market
interest rates make interest-bearing deposit products more attractive to
customers and may cause funds to shift from non-interest checking into
interest-bearing deposit products.
Provision for Loan Losses. For the nine months ended September 30, 2007,
we took a $45,000 credit to the provision for loan losses, compared to a zero
provision for loan losses for the nine months ended September 30, 2006. The
credit to the provision for loan losses was due to the decline of the loan
portfolio balance, and the level of recoveries on loans previously charged-off,
which are added to the allowance for loan losses. The provision for loan losses
in any period depends upon the amount necessary to bring the allowance for loan
losses to the level management believes is appropriate, after taking into
account charge offs and recoveries. Our
20
allowance for loan losses is based on management's evaluation of the risks
inherent in our loan portfolio and the general economy. Management periodically
evaluates both broad categories of performing loans and problem loans
individually to assess the appropriate level of the allowance.
Although management uses available information to assess the
appropriateness of the allowance on a quarterly basis in consultation with
outside advisors and the board of directors, changes in national or local
economic conditions, the circumstances of individual borrowers, or other
factors, may change, increasing the level of problem loans and requiring an
increase in the level of the allowance. The allowance for loan losses
represented 1.62% of total loans at September 30, 2007, but there can be no
assurance that a higher level, or a higher provision for loan losses, will not
be necessary in the future.
Non-interest Income. Non-interest income was $1,616,193 for the nine
months ended September 30, 2007, compared to $1,408,944 during the same period
last year. The $207,249, or 14.7%, increase in non-interest income was a direct
result of a $175,978 increase in service charges on deposits (primarily
non-sufficient fund fees) and a $33,594 increase in other income. Service fees
on deposit accounts, principally non-sufficient funds fees, increased from 2006
to 2007 as the volume of deposit account transactions generating fee income
increased. The increase in other income is a direct result of the Bank taking on
a select, limited group of licensed consumer check cashing companies as deposit
customers. These companies generate fee income through per item charges on their
deposits.
Non-interest Expense. Non-interest expense was $5,464,468 for the nine
months ended September 30, 2007, compared to $5,435,532 for the nine months
ended September 30, 2006. The principal causes of the $28,936 increase were:
o an $18,807 decrease in salaries and benefits expense, due to a reduction
in our incentive compensation accrual and a decrease in SAR related
expenses, due to a decline in our stock price, partially offset by normal
salary increases, a slight increase in staffing and higher benefit costs.
o $217,648 in higher occupancy expenses due to the operation of our branch
in Rosebank and the opening of our new main office in Great Kills.
o a $228,829 decrease in legal expenses due to the reimbursement from our
insurance company of legal fees previously expensed and a reduction in
attorney fees from the 2006 period.
Income Tax Expense. Income tax expense was $1,337,997 for the nine months
ended September 30, 2007, compared to income tax expense of $1,589,224 for the
nine months ended September 30, 2006. The $251,227 reduction in income tax
expense was due to the $538,966 decrease in income before income taxes in the
2007 period. Our effective tax rate remained the same for the nine months ended
September 30, 2007 and 2006 at 46.6%.
21
VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)
Three Three
Months Ended Months Ended
September 30, 2007 September 30, 2006
---------------------------------- -----------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------- ----------- ------ ------------- ----------- -------
Assets:
Interest-earning assets:
Loans receivable $ 59,328,064 $ 1,500,123 9.75% $ 69,220,537 $ 1,794,879 10.19%
Investment securities, afs 111,074,416 1,320,528 4.72 116,174,628 1,336,087 4.56
Other interest-earning assets 24,203,811 297,268 4.87 22,297,337 282,049 5.02
------------- ----------- ------------- -----------
Total interest-earning assets 194,606,291 3,117,919 6.30 207,692,502 3,413,015 6.49
Non-interest earning assets 13,590,653 13,956,539
------------- -------------
Total assets $ 208,196,944 $ 221,649,041
============= =============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 11,684,293 24,531 0.83 $ 13,372,021 23,607 0.70
Time accounts 66,513,594 619,975 3.70 75,616,485 662,769 3.48
Money market accounts 24,043,528 137,741 2.27 18,211,593 85,246 1.86
Now accounts 19,471,134 37,940 0.77 22,036,471 27,867 0.50
Short Term Borrowings -- -- -- 76,087 1,112 5.80
Subordinated debt 5,155,000 89,040 6.91 5,155,000 89,040 6.91
------------- ----------- ------------- -----------
Total interest-bearing liabilities 126,867,549 909,227 2.84 134,467,657 889,641 2.62
Checking accounts 60,571,625 68,859,364
------------- -------------
Total deposits and subordinated debt 187,439,174 203,327,021
Other liabilities 1,617,370 2,452,036
------------- -------------
Total liabilities 189,056,544 205,779,057
Equity 19,140,400 15,869,984
------------- -------------
Total liabilities and equity $ 208,196,944 $ 221,649,041
============= =============
Net interest income/net interest rate spread $ 2,208,692 3.46% $ 2,523,374 3.87%
=========== ====== =========== =======
Net interest earning assets/net interest margin $ 67,738,742 4.45% $ 73,224,845 4.79%
============= ====== ============= =======
Ratio of interest-earning assets to interest-
bearing liabilities 1.53 x 1.54 x
============= =============
Return on Average Assets (1) 0.92% 1.14%
============= =============
Return on Average Equity (1) 9.99% 15.87%
============= =============
Tangible Equity to Total Assets 9.57% 7.45%
============= =============
Nine Nine
Months Ended Months Ended
September 30, 2007 September 30, 2006
---------------------------------- -----------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------- ----------- ------ ------------- ----------- -------
Assets:
Interest-earning assets:
Loans receivable $ 60,982,376 $ 4,573,820 9.98% $ 71,136,492 $ 5,301,788 9.91%
Investment securities, afs 111,043,148 3,914,686 4.71 113,578,686 3,862,518 4.55
Other interest-earning assets 21,823,634 809,094 4.96 17,183,553 594,676 4.63
------------- ----------- ------------- -----------
Total interest-earning assets 193,849,158 9,297,600 6.40 201,898,731 9,758,982 6.44
Non-interest earning assets 14,920,697 14,067,821
------------- -------------
Total assets $ 208,769,855 $ 215,966,552
============= =============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 12,082,515 74,314 0.82 $ 13,679,963 62,985 0.62
Time accounts 66,788,460 1,862,985 3.73 69,745,174 1,647,723 3.16
Money market accounts 20,828,643 321,150 2.06 19,631,360 264,909 1.80
Now accounts 19,672,772 96,689 0.66 21,470,419 77,512 0.48
Short Term Borrowings -- -- -- 25,641 1,112 5.80
Subordinated debt 5,155,000 267,119 6.91 5,155,000 267,119 6.91
------------- ----------- ------------- -----------
Total interest-bearing liabilities 124,527,390 2,622,257 2.82 129,707,557 2,321,360 2.39
Checking accounts 63,532,608 68,457,394
------------- -------------
Total deposits and subordinated debt 188,059,998 198,164,951
Other liabilities 2,012,645 2,458,242
------------- -------------
Total liabilities 190,072,643 200,623,193
Equity 18,697,212 15,343,359
------------- -------------
Total liabilities and equity $ 208,769,855 $ 215,966,552
============= =============
Net interest income/net interest rate spread $ 6,675,343 3.58% $ 7,437,622 4.05%
=========== ====== =========== =======
Net interest earning assets/net interest margin $ 69,321,768 4.59% $ 72,191,174 4.91%
============= ====== ============= =======
Ratio of interest-earning assets to interest-
bearing liabilities 1.56 x 1.56 x
============= =============
Return on Average Assets (1) 0.97% 1.12%
============= =============
Return on Average Equity (1) 10.89% 15.75%
============= =============
Tangible Equity to Total Assets 9.57% 7.45%
============= =============
22
Liquidity and Capital Resources
Our primary sources of funds are increases in deposits, proceeds from the
repayment of investment securities, and the repayment of loans. We use these
funds to purchase new investment securities and to fund new and renewing loans
in our loan portfolio. Remaining funds are invested in short-term liquid assets
such as overnight federal funds loans and bank deposits.
During the nine months ended September 30, 2007, we had a net decrease in
total deposits of $5,611,356 due to a $4,621,334 decrease in time deposits, a
$4,824,412 decrease in demand and checking accounts and a $1,416,790 decrease in
savings accounts partially offset by a $5,226,118 increase in money market
accounts and a $25,062 increase in NOW accounts. We received proceeds from
repayment of investment securities of $24,358,579 and we had a net loan
reduction of $6,961,389. After funding the deposit decline, we used $19,513,770
of available funds to purchase new investment securities. We also used
$2,934,194 of cash for capitalized leasehold improvements and equipment for our
new main office in Great Kills. These changes resulted in an overall increase in
cash and cash equivalents of $6,888,630.
In contrast, during the nine months ended September 30, 2006, our retail
banking activities generated a net increase in deposits of $4,140,330 and we had
a net decrease in loans receivable of $8,081,181, which combined to generate
$12,221,511 in cash. In addition, we received proceeds from repayment of
investment securities of $16,031,264. We used $23,944,173 of available funds to
purchase new investment securities, resulting in an overall increase in cash and
cash equivalents of $4,730,238. We applied available funds principally to
purchase the $23,944,173 of investment securities to increase investment
collateral available to pledge for the $20 million in municipal CDs that we
received in the second quarter of 2006 in connection with our opening of our
Rosebank branch.
Victory State Bank satisfied all capital ratio requirements of the Federal
Deposit Insurance Corporation at September 30, 2007, with a Tier I Leverage
Capital ratio of 12.04%, a ratio of Tier I Capital to Risk-Weighted Assets ratio
of 28.68%, and a Total Capital to Risk-Weighted Assets ratio of 29.78%.
VSB Bancorp, Inc. satisfied all capital ratio requirements of the Federal
Reserve at September 30, 2007, with a Tier I Leverage Capital ratio of 12.37%, a
ratio of Tier I Capital to Risk-Weighted Assets ratio of 29.41%, and a Total
Capital to Risk-Weighted Assets ratio of 30.52%.
The following table sets forth our contractual obligations and commitments
for future lease payments, time deposit maturities and loan commitments.
23
Contractual Obligations and Commitments at September 30, 2007
Contractual Obligations Payment due by Period
-----------------------------------------------------------------------------
Less than One to three Four to five After Total Amounts
One Year years years five years committed
------------- ------------- ------------- ------------- -------------
Minimum annual rental payments under
non-cancelable operating leases $ 393,057 $ 801,132 $ 829,865 $ 2,322,506 $ 4,346,560
Remaining contractual maturities of time
deposits 60,839,409 984,783 1,783,718 -- 63,607,910
------------- ------------- ------------- ------------- -------------
Total contractual cash obligations $ 61,232,466 $ 1,785,915 $ 2,613,583 $ 2,322,506 $ 67,954,470
============= ============= ============= ============= =============
Other commitments Amount of commitment Expiration by Period
-----------------------------------------------------------------------------
Less than One to three Four to five After Total Amounts
One Year years years five years committed
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
Loan commitments $ 16,374,330 $ 8,940,443 $ -- $ -- $ 25,314,773
============= ============= ============= ============= =============
Our loan commitments shown in the above table represent both commitments
to make new loans and obligations to make additional advances on existing loans,
such as construction loans in process and lines of credit. Substantially all of
these commitments involve loans with fluctuating interest rates, so the
outstanding commitments do not expose us to interest rate risk upon fluctuation
in market rates.
Critical Accounting Policies and Judgments
We are required to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the amounts of revenues
and expenses during the reporting period. The allowance for loan losses,
prepayment estimates on the mortgage-backed securities and Collateralized
Mortgage Obligation portfolios, contingencies and fair values of financial
instruments are particularly subject to change and to management's estimates.
Actual results can differ from those estimates and may have an impact on our
financial statements.
Item 3 - Controls and Procedures
Evaluation of Disclosure Controls and Procedures: As of September 30,
2007, we undertook an evaluation of our disclosure controls and procedures under
the supervision and with the participation of Merton Corn, President and CEO,
and Raffaele M. Branca, Executive Vice President and CFO. Disclosure controls
are the systems and procedures we use that are designed to ensure that
information we are required to disclose in the reports we file or submit under
the Securities Exchange Act of 1934 (such as annual reports on Form 10-KSB and
quarterly periodic reports on Form 10-QSB) is recorded, processed, summarized
and reported, in a manner which will allow senior management to make timely
decisions on the public disclosure of that information. Messrs. Corn and Branca
concluded that our current disclosure controls and procedures are effective in
ensuring that such information is (i) collected and communicated to senior
management in a timely manner, and (ii) recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms. Since
our last evaluation of our disclosure controls, we have not made any significant
changes in, or corrective actions taken regarding, either our internal controls
or other factors that could significantly affect those controls.
We intend to continually review and evaluate the design and effectiveness
of our disclosure controls and procedures and to correct any deficiencies that
we may discover. Our goal is to ensure that senior management has timely access
to all material financial and non-financial information concerning our business
so that they can evaluate that information and make determinations as to the
nature and timing of disclosure of that information. While we believe the
present design of our disclosure controls and procedures is effective to achieve
this goal, future events may cause us to modify our disclosure controls and
procedures.
24
Part II
Item 1 - Legal Proceedings
The Bank is a defendant in an action pending in Supreme Court, Richmond County,
commenced by IndyMac Bank, F.S.B. against the Bank, LaMattina & Associates, Inc.
("LAI") and various individuals and entities alleged to be officers, directors
or otherwise to have relationships with LAI. LAI was a deposit customer of the
Bank engaged in the business of providing real estate settlement services to
lenders making residential mortgage loans. The plaintiff alleges that it was
such a lender and that it had provided funds to LAI by wiring those funds to an
account of LAI at the Bank to use to fund mortgage loans to be made by the
plaintiff, only to have LAI not use those funds for their intended purpose. The
action was commenced in August 2005. In November 2005, the plaintiff amended its
complaint to add the Bank as a defendant. The plaintiff amended its complaint
again and the Bank moved to dismiss the claims. In February 2007, the court
dismissed two of the claims against the Bank but allowed the Plaintiff to
proceed and conduct discovery with respect to two claims, one for negligence and
the other for conversion.
The amended complaint requests monetary damages against the Bank of $1,817,041.
The Bank intends to defend aggressively the amended claims and has referred the
litigation to its insurance carrier, which has indicated that the claims
asserted against the Bank are covered by insurance. The Bank has also asserted
cross-claims against various former customers, principals of those customers,
and other related persons on the grounds that if the Bank is held liable to the
plaintiff, then the liability is the result of the misdeeds or negligence of
those other parties. Pre-trial discovery among the parties is in process.
VSB Bancorp, Inc., is not involved in any pending legal proceedings. The Bank,
from time to time, is involved in routine collection proceedings in the ordinary
course of business on loans in default. Management believes that such other
routine legal proceedings in the aggregate are immaterial to our financial
condition or results of operations.
25
Signature Page
In accordance with the requirements of the Exchange Act, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
VSB Bancorp, Inc.
Date: November 12, 2007 /s/ Merton Corn
----------------------------------------------
Merton Corn
President and Chief Executive Officer
Date: November 12, 2007 /s/ Raffaele M. Branca
----------------------------------------------
Raffaele M. Branca
Executive Vice President and Chief Financial
Officer
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------- ----------------------
31.1 Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2 Rule 13A-14(a)/15D-14(a) Certification of Chief Financial Officer
32.1 Certification by CEO pursuant to 18 U.S.C. 1350.
32.2 Certification by CFO pursuant to 18 U.S.C. 1350.
----------------------------------------
Item 6 - Exhibits
Exhibit
Number Description of Exhibit
------- ----------------------
31.1 Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2 Rule 13A-14(a)/15D-14(a) Certification of Chief Financial Officer
32.1 Certification by CEO pursuant to 18 U.S.C. 1350.
32.2 Certification by CFO pursuant to 18 U.S.C. 1350.
26